The Federal Reserve held interest rates steady on Wednesday, just as almost everyone expected. I imagine even President Trump wasn’t surprised.
As I noted on Monday, he and Fed Chair Jerome Powell have had their definite disagreements (to put it mildly) over the past eight years. So despite Trump telling Davos participants earlier this month that rates had to come down immediately…
Powell and Co. did as they saw fit.
Who will win the ultimate battle is up for debate. But most economic experts don’t think there will be any reductions for months more.
In which case, you’re excused if you think there’s no hope for mortgage rates and that the housing market is doomed to continue plodding along with its all-around unaffordability.
But the truth is that it’s not just the Federal Reserve that affects how much interest banks charge for home loans. The matter is much more complex than that, with the following forces weighing in as well:
- Inflationary forces
- The 10-year Treasury
- Housing supply and demand
- Default and foreclosure levels
Moreover, let’s face it… We’re in pretty unprecedented times right now. The Covid-19 situation five years ago was an enormously unusual event that is still impacting us today.
It drove government spending up, which automatically impacts inflation. And it sent people racing to buy homes after a decade of unimpressive housing market movements.
Those are two factors that Trump can positively impact by:
- Lowering government spending, thereby bringing the amount of dollars in circulation back under control
- Making it easier and more profitable for homebuilders to do what they do through tax cuts and deregulation
With all that in mind, it seems high time to discuss these companies and how they could perform from here. For my part, I’m pretty optimistic over the long term.
However, there are more immediate hurdles we have to acknowledge if we’re going to benefit from homebuilders’ eventual growth.
The Good and the Bad Homebuilders Face Today
Homebuilders are on particular display right now as the fourth-quarter 2024 and full-year earnings emerge. And, so far, we’ve got some good news coming in – so much so that, as of Wednesday – they grew by around 5%.
That was pretty welcome news to their shareholders considering how they’d dropped nearly 25% over the previous two months.
KB Home (KBH), for instance, had a strong finish to the year – not that you’d know it based on yesterday’s share price activity. Despite sinking 1.83% on the Fed’s decision, it reported around $2 billion in total 2024 revenue. That’s up 8.1% over 2023.
And earnings per diluted share grew by 36%. So it seems safe to say this homebuilder can survive, even with interest rates as-is.
The much more expensively priced NVR (NVR) – trading at $7,990 before the bell this morning – reported its own positive results yesterday. Revenue rose more than 11% to $10.52 billion, and earnings per share increased 9%.
That news wasn’t enough to keep the stock from tumbling $99.08 yesterday, or 1.23%. Though it looked like it was going to get a nice chunk of that right back today last time I looked.
It’s just one more piece of proof that investors have a very bad habit of overreacting in the short term. Then again, we do have to consider another homebuilder, D.R. Horton (DHI).
While it did post stronger-than-expected revenue and its balance sheet continues to be strong… it also used its earnings call to temper investors’ expectations, with CEO Paul Romanowski explaining how:
To help spur demand and address affordability, we are continuing to use incentives such as mortgage rate buydowns. And we have continued to start and sell more of our smaller floor plans.
Truth be told, most other homebuilders are in similarly tight situations. So while I do think the markets overreacted to the Fed’s changeless decision yesterday…
I also don’t think homebuilder share prices should be surging just yet. With one exception, we’ve still got some milestones to reach before this bull market can really get underway.
How to Handle Homebuilders As We Wait for “The Trump Effect” to Kick In
It’s easy to see that home affordability remains far too stretched for most Americans right now. Current monthly payments on a median-priced single-family existing home take up a whopping 30% of median household income.
That’s close to the highest it’s ever been, with the last record set in the 1980s. And it’s well above the long-term average of 21%.
While rental costs aren’t necessarily any better, depending on where you look, there’s little chance for renters to save and therefore little room for them to consider homeownership. If home prices hold from here, mortgage rates would need to drop to about 4% for affordability to normalize back down to long-term averages.
They currently sit near 7%.
I fully believed now-White House Press Secretary Karoline Leavitt last November when she said that “Trump can be trusted to restore the American dream because he has a real plan to defeat inflation, bring down mortgage rates, and make purchasing a home dramatically more affordable.”
And I continue to agree with her that:
He will rein in federal spending, stop the unstainable [sic] invasion of illegal aliens which is driving up housing costs, cut taxes for American families, eliminate costly regulations, and free up appropriate portions of federal land for housing.
But that will take more than a few months’ worth of work after years of destructive buildup.
Fortunately for us, that garden-style recession I’m still predicting should help speed up Trump’s results. Recessions mean rate drops, after all, bringing the president’s opinions in line with Fed Chair Powell. And rate drops should infuse homebuyers with more immediate confidence and capabilities.
That’s why I won’t pull the trigger on any new homebuilder buys for now… with the exception of one (or two). Toll Brothers (TOL) might be worth looking at considering its unique positioning in the housing market.
It builds for a much wealthier clientele who often pay for their houses outright. Or at least with significant money down. So mortgage rates just don’t affect it the same way.
Nearly 28% of Toll’s buyers paid all cash in the fourth quarter of 2024 with those taking a mortgage making a substantial (31%) down payment. I view Toll Brothers as a more defensive play; shares have been the best performer over a one-year period and I believe that this outperformance will continue.
I’m also studying another homebuilder outlier for Wide Moat Confidential, my exclusive community in which I screen for some of the best small-cap stock ideas.
Having a background in real estate has given me an edge versus other analysts, and our team will always seek to find quality and value in every asset class, including housing which is part of the American Dream.
I promise to keep you informed so that you can make the most intelligent decisions to help you sleep well at night.
Regards,
Brad Thomas
Editor, Wide Moat Daily
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